Can MBS investors rebound after N.Y. high court shuts down contract suits?

June 11, 2015

(Reuters) – To the relief of every bank that issued mortgage-backed securities in the heyday of subprime lending, New York’s highest court, the Court of Appeals, ruled Thursday that the six-year statute of limitations for investors’ breach-of-contract claims begins to run on the date the MBS contract was executed – and not, as investors had argued, when MBS trustees fail to repurchase underlying mortgages that don’t meet issuers’ representations and warranties.

The court’s ruling in ACE Securities v. DB Structured Products, written by Judge Susan Read, is not only a total victory for Deutsche Bank and its lawyers at Simpson Thacher & Bartlett but good news for all kinds of businesses that include representations and warranties in their contracts. The U.S. Chamber of Commerce and the Business Roundtable, in an amicus brief backing Deutsche Bank, had warned that if the state high court sided with MBS investors, uncertainty about contractual liability would undermine New York’s commercial preeminence. The Court of Appeals implicitly agreed, highlighting the “finality, certainty and predictability” New York’s statute of limitations is intended to serve.

The most obvious beneficiaries of Thursday’s decision are MBS issuers. The trial judge overseeing MBS breach-of-contract suits in New York State Supreme Court, Justice Marcy Friedman, had already dismissed a wave of late-filed MBS investor suits after an intermediate state appeals court first ruled for Deutsche Bank in the Ace case. According to Robert Fumerton of Skadden Arps Slate Meagher & Flom, who has closely followed the MBS statute-of-limitations issue, only a handful of investor suits were stayed to await the Court of Appeals’ Ace ruling. Those cases, as well as a small number of MBS breach-of-contract suits in federal court, will likely now be tossed.

But more significantly, the Court of Appeals decision means MBS investors can’t revive dismissed cases and can’t file new suits over issuers’ alleged breaches of representations and warranties. Issuers’ lingering MBS liability, in other words, now has defined outer limits. If the Court of Appeals had adopted the expansive interpretation of the statute of limitations advanced by Paul Clement of Bancroft, who argued the Ace case for MBS trustee HSBC, issuers could have been on the hook to repurchase deficient underlying loans for the entire life of an MBS trust.

Skadden partner Fumerton predicted MBS investors will attempt to refashion their cases to sidestep Thursday’s decision. Instead of alleging a breach of representations and warranties on the underlying loans, he said, certificate holders may claim that issuers failed to notify them when they discovered problems.

Will the strategy work? It hasn’t so far in New York state court, where Justice Friedman has said failure to notify claims are just duplicates of stale representation and warranties allegations, Fumerton said.

The Court of Appeals opinion should only strengthen that conclusion. The court said, effectively, that the entire MBS repurchase regime – in which investors have the right to demand that issuers buy back deficient underlying loans – is the sole remedy for breaches of MBS contracts. According to Thursday’s ruling, investors do not have independent causes of action based on alleged failures to comply with any of the many steps in the repurchase process. The court rejected investors’ theory that Deutsche Bank breached its put-back obligations every time it refused to buy back a mortgage that didn’t live up to contractual promises.

“In sum, DBSP’s cure or repurchase obligation was not a separate and continuing promise of future performance,” the court said. “Viewed in this light, the cure or repurchase obligation was not an independently enforceable right, nor did it continue for the life of the investment.”

Given that language, it’s tough to imagine that investors can successfully argue issuers are independently liable for failing to notify them of problem mortgages, which is an earlier step in the repurchase process.

But certificate holders like those in the Ace case, who say they lost about $250 million, will probably give the alternate theory a try anyway. After all, they don’t have much to lose.

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